image source: WSJ
As we have been discussing with clients and writing in our newsletters, the global growth rates that the markets have been “baking in” are somewhat optimistic. Earlier this year, stock market valuations in the US were projecting we would reach a 3% GDP growth rate, not the 2.0-2.25% we have been experiencing for the last 5 years.
And the US is actually doing better than most other developed countries. Both Europe and Japan are growing even slower or not at all.
So what is behind the global growth slowdown? Is it geopolitical events, such as ISIS, the Ukraine-Russia standoff, or political tensions in Asia? Is it continuing economic austerity? Is it stagnant wage growth due to corporate greed? Brian Wesbury has a tremendous opinion piece in today’s Wall Street Journal that I think crystalizes the issue nicely. He writes:
“Governments are engaged in deficit spending like they did in the 1970s. It didn’t work then to boost growth, and it isn’t working now. Euro area government spending was 49.8% of GDP in 2013 versus 46.7% in 2006. In other words, euro area governments have co-opted an additional 3.1% of GDP (roughly €300 billion) compared with before the crisis—about the size of the Austrian economy.
France spent 57.1% of GDP in 2013 versus 56.7% in 2009, at the peak of the crisis. This is the opposite of austerity—but the French economy hasn’t grown in more than six months. It is no wonder S&P downgraded its debt rating.
Italy, at 50.6% of GDP, is spending more than the euro area average but is contracting faster.
Every economy can be divided into two parts: private and public sectors. The larger the slice taken by the government, the smaller the slice left over for the private sector, which means fewer jobs and a lower standard of living.
If government were more productive than private business this wouldn’t be true, but government is not. For example, alternative energy (solar, wind, biofuels) may, might, could possibly, generate cheaper, cleaner, renewable energy in the future. Right now these industries survive because of subsidies. These subsidies are drawn out of revenues extracted from profitable, job-creating industries, which means fewer private jobs, less private investment and less private saving.”
This is the heart of the issue — ballooning government spending crowds out private enterprise, which is the engine that creates true growth in any economy. It is the growth that creates jobs, encourages investment, stimulates markets, and funds government coffers.
But what about central banks? We all know they are manipulating the current economic environment with a seemingly endless supply of money. Shouldn’t that stimulate the private sector to borrow, spend, and invest our way to higher growth? To quote Janet Yellen, ”as Japan found during its quantitative easing program, increasing the size of the monetary base above levels needed to provide ample liquidity to the banking system had no discernible economic effects.” Mr. Wesbury goes on to explain:
“For quantitative easing to work, it must boost the broader money supply. The Fed’s monetary base (currency in circulation and reserve balances) has grown 28.8% per year since QE started. If banks had multiplied this high-powered liquidity, the broader M2 measure of money (all deposits at banks, including money market accounts and cash) would have grown at the same rate. But M2, the measure Milton Friedman told us to watch, has grown just 6.7% per year. If banks had lent most of this new money, M2 and inflation would have accelerated sharply. But excess (unused) reserves are now at $2.7 trillion. This is why inflation has not accelerated.
Keynesians call this a ‘liquidity trap’—a condition in which consumers will not spend and businesses will not invest. In reality it’s the ‘big government trap’—a condition where the government siphons off the benefits of private growth and investment before they reach the economy as a whole.
The U.S. is growing faster than Europe not because of QE, but because, believe it or not, our government is relatively smaller. Federal, state and local expenditures in the U.S. were 36.5% of GDP in 2013. This is too high, but because it is less than Europe, the U.S. has a larger and more vibrant private sector. The U.S. is leading the world in energy production because of technology such as hydraulic fracturing and horizontal drilling. Meanwhile 3-D printing, the cloud, apps, nano- and biotechnology are being fueled and financed by private business.
Central bankers don’t stay up at night writing apps, and U.S. senators don’t develop natural-gas plays. Private business creates wealth and the U.S. private sector still leads the world.
I encourage you to read the rest of his article, but this is enough to make my point. The world will continue to experience dampened growth prospects until governments around the world realize that the best thing they can do to stimulate their economies is just simple, get out of the way.
